Combined Loan & Bond Portfolios

Transcription

1 An efficient way to invest in Sub-Investment Grade Debt Harry Sugiarto, Portfolio Manager

2 Executive Summary Investors in sub-investment grade debt typically look to the asset class to provide a high and stable income with downside protection and low correlation to other mainstream financial markets. Many of these benefits are accessible by investing into either High Yield Bonds or Senior Secured Loans and both are attractive standalone investment opportunities. Reasons such as regulatory requirements, size constraints, or other investment limitations may explain why investors tend to choose an investment into only one or other of these asset classes. However, we feel a managed portfolio that can freely invest across both Senior Secured Loans and High Yield Bonds is an even more efficient way to invest in sub-investment grade debt. It allows the manager to fully apply their expertise and make the most of the existing opportunities. There are a number of reasons why investing on a combined basis can improve a loan or bond-only portfolio: Pricing is inefficient Relative value between the two markets can improve returns for a given risk Structural differences Bonds and loans are structured differently and have different risk/return characteristics A combined mandate allows an asset manager to tailor their investment to their credit view Market size A combined mandate gives the asset manager a broader opportunity set to select from Separating allocations to High Yield and Leveraged Loans can create name overlap risks Increasing integration of loan and bond markets Issuers will continue to move between markets as funding conditions fluctuate Asset managers operating in both markets will have a better understanding of these issuers businesses Over the following pages, we lay out why we believe such an investment approach to be beneficial and explain the advantages in more detail. Intermediate Capital Group plc Page 2

3 Introduction In our document The Case for European Sub-Investment Grade Debt, we discussed the origins and development of the senior secured loan and high yield bond markets, and how including these strategies in a broader portfolio can lead to superior risk-adjusted returns over a pure equity and/or government bond based investment strategy. We consider senior secured loans and high yield bonds to be very similar asset classes. We believe that the primary driver of performance in each asset class is credit selection and default avoidance. Both require a disciplined, bottom-up approach to cash-flow lending. In addition, these markets have many issuers in common, with leveraged buyouts representing a significant proportion of each universe. In this paper we outline why an integrated approach to senior secured loan and high yield bond investing, where a single asset manager invests flexibly across bonds and loans, can generate incremental value for investors. We believe there to be a number of reasons why this is the case: Pricing is inefficient. Loans and bonds do not offer the same returns for taking credit risk, neither on a market-wide basis nor a single-credit basis. Structural differences. Loans and bonds typically offer differing levels of protection and financial payoffs. Having the flexibility to access both markets allows an investor to tailor their investment to their view. Market size. The combined size of the European loan and high yield market is 4-5bn, comprising around 15-2bn of bonds and 25-3bn of loans. Investing across both markets can substantially widen the number of investment opportunities available, with positive implications for the quality of the investment ideas selected for a portfolio. Increasing integration of bond and loan markets. Loan issuers are increasingly looking to the bond market for debt financing. The issuer overlap between the loan and bond market is significant and likely to increase even more going forward. Integrated mandates allow an asset manager to use prior investment knowledge and follow their money as issuers move between these markets. Issuers have pitted bond and loan markets against each other for a long time to optimise their debt financing. The investor should be positioned to do the same. Identifying where loans are over or under-valued versus high yield bonds and reallocating accordingly allows an asset manager to create a portfolio invested in the most attractive markets, companies, and debt instruments at any given point in time. Under fixed, separate mandates, each asset manager is forced to invest in their respective market even when the other asset class offers better value, with the bond/loan asset allocation decision one step removed. Reallocation decisions between loans and bonds under this framework are likely to be slower and more expensive than under a combined mandate. Fundamentally, we believe that delegating the allocation decision within these two closely-related markets to a single asset manager can enhance the potential risk and return outcomes available to investors. The chart below (Figure 1) illustrates this approach: Fig. 1 Traditional Allocation Model m High Yield Bond Manager m High Yield Bond Portfolio Source: ICG Investor Asset Allocation m Leveraged Loan Manager m Leveraged Loan Portfolio Combined Allocation Model Investor 2m Combined Bond & Loan Manager 125m Asset Allocation 75m High Yield and Leveraged Loan Portfolio Intermediate Capital Group plc Page 3

4 Combined Senior Secured Loan & High Yield Bond Portfolios Pricing is inefficient Loans and bonds do not always offer the same returns for taking the same risks. Broadly speaking, we see two illustrations of this theme: Top-down: Loans and bonds as an asset class can offer significantly different returns for very similar risk (for example, when adjusting for ratings and recovery expectations). Bottom-up: Loans and bonds within the same company often do not offer the same returns On the first point, the chart below (Figure 2) shows the historical spread premium for B-rated bonds over B-rated loans: Fig. 2: Yield difference between B rated loans & bonds Dec 2 Dec 4 Dec 6 Dec 8 Dec 1 Dec 12 Source: BAML, S&P LCD ML EURO CORP B index yield - ELLI B 3Y yield (bps) The chart shows that in stable or positively trending markets, bonds and loans of equivalent ratings have offered broadly similar spreads. However, in periods of market stress (e.g. 28 and summer 211), bonds tend to widen more than loans, then offering significantly more yield for similar default risk. We believe that this periodic dislocation in valuations in large part reflects the nature of the investor base in each asset class. Banks represent around 5% of the European senior secured loan investor base by assets. Banks generally have fairly stable allocations to leveraged bank loans, particularly in the short-term. Banks do not typically mark-to-market but are cognisant of market values of their loans, typically making provisions against loan valuations depending on borrower performance. In some instances banks may be reluctant to sell loans so as to not damage their relationship with a borrower. CLOs represent around 3% of the loan investor base by assets. Collateralised loan obligations (CLOs) are closed-end funds that raise capital to invest over a multi-year investment period. Redemptions of their investment capital within the investment period are rare. CLOs do not actively mark-tomarket, with credit ratings and default experience within their portfolios key drivers of portfolio performance. A CLO s investment strategy usually requires them to be fully invested. Other institutional investors include hedge funds and specialist funds focussed on senior secured loans. This capital is generally less sticky: Hedge funds may increase or decrease their allocations depending on market opportunity and loan funds typically offer their investors periodic liquidity. These investors generally mark-to-market. As such, most of the capital invested in this market is via banks and CLOs, who are generally not mark-to-market investors with access to long-term capital. Whilst secondary market prices of senior secured loans will ultimately reflect the quality of individual loans and broader market conditions, we view the secondary market as relatively stable, with large swings in the demand and supply of loan assets (and therefore prices) being relatively rare. In contrast, we view the high yield bond investor base as market-value sensitive. Whilst many high yield investors might invest with a long-term horizon, high yield asset managers usually offer their investors frequent liquidity. As such, the rapid withdrawal or deployment of capital from or into the high yield market due to changes in investor sentiment can intensify price movements. The chart below (Figure 3) shows JPMorgan data tracking net flows of high yield funds since early 27. Whilst the trend has been long-term positive as investors have increased allocations to the asset class, redemptions from high yield funds have periodically reached 1% of total AUM over short periods. Fig. 3: European HY fund flows Source: JPMorgan Intermediate Capital Group plc Page 4

5 We believe that the flow of capital into and out of the high yield market can create periods where bond valuations are generally more or less attractive than loans, particularly in periods of high volatility. A strategy where allocations are progressively tilted towards bonds after a market sell-off could generate significant long-run outperformance, without taking additional default risk within the portfolio. We illustrate this opportunity using examples where the yields available on equally-ranked bonds and loans within an issuer s capital structure have varied over time. 1. Smurfit Kappa Smurfit Kappa is the European leader in the manufacture of corrugated cardboard boxes. The company has been a benchmark issuer in the senior secured loan and high yield markets for a decade. In 29, the company issued 1bn of senior secured bonds, using proceeds to repay its senior secured loans. The charts below (Figure 4 a-c) compare the yields and prices on the company s Term Loans and the High Yield Bond, which rank equally in a default. Both instruments are BB / Ba2 rated with S&P and Moody s. Fig. 4a: Smurfit Kappa Loan and Bond Prices SKG Loan Price SKG 7.25% due 217 Bond Price 9 Dec 9 Jun 1 Dec 1 Jun 11 Dec 11 Jun 12 Dec 12, ICG Fig. 4b: Smurfit Kappa Loan and Bond Yields SKG Loan Yield, % SKG 7.25% due 217 Bond Yield, % 1 Dec 9 Jun 1 Dec 1 Jun 11 Dec 11 Jun 12 Dec 12, ICG Fig. 4c: Smurfit Kappa Bond-Loan Yield Differential Dec 9 Jun 1 Dec 1 Jun 11 Dec 11 Jun 12 Dec 12, ICG SKG Bond-Loan Yield Differential, bps The charts show that the bank term loan price has been relatively stable throughout, trading in a narrow 4-5 point range, and not significantly above par. In contrast, the bond has traded more in-line with the wider high yield market, with a far wider price and yield range. The yield premium available for investing in the bond over the loan reached 3bps in September 211. This means selling out of the loan and buying the bond at this point would earn the investor an extra 3% in income per year. Alternatively, as was the case in this situation, the normalisation of this differential would give incremental capital gains to the bond investor (Figure 4a). Why do these dislocations exist? Smurfit Kappa has been a benchmark issuer in the senior secured loan market for a number of years. Given the high rating on the loan, we believe banks and CLOs would be reluctant to sell their holdings in the name significantly below par and crystallising a loss on sale, putting a floor under the loan price. In contrast, bondholders tend to be more relative value oriented, with bond yields likely to be more reflective of broader market conditions. Note that segmentation of investment mandates (banks generally do not buy bonds and vice versa) allows these dislocations to persist. Intermediate Capital Group plc Page 5

6 2. Wind Wind is an operator of mobile and fixed line telecom networks in Italy. In October 21 the Company issued 1.75bn of senior secured high yield bonds to repay senior term loans. Both instruments are rated BB-/Ba3 and rank equally in default. Charts showing yield and price development on each instrument are shown below (Figure 5 a-c): Fig. 5a: Wind Loan and Bond Prices Wind Loan Price Wind 7.375% due 218 Bond Price 7 Dec 1 Jun 11 Dec 11 Jun 12 Dec 12 Fig. 5b: Wind Loan and Bond Yields Wind Loan Yield, % 4 Wind 7.375% due 218 Bond Yield, % Dec 1 Jun 11 Dec 11 Jun 12 Dec 12 Whilst the Wind term loan has not been immune from recent volatility, having traded in a 14 point range over this period, the bond has been significantly more volatile with a 25 point trading range (Figure 5a). Concerns over the Italian sovereign position have had a more marked effect on the bond s price, leading to a widening of the bond-loan yield differential. At times, the bond has offered significant additional yield versus the loan, reaching a maximum 241bps in November 211, having traded 132bps tighter than the loan as recently as May 211 (Figure 5c). Figure 5d overlays the Italian 5-year sovereign bond yield over the same period. The bond-loan yield differential shows a broad, if not exact, relationship with Italian sovereign bond yields over time. Again, significant opportunities to capture additional income exist by reallocating between Wind loans and bonds as yield differentials dictate. Fig. 5d: Wind Bond-Loan Diff vs Italian Gov t Yield Bond-Loan Yield Differential, bps (lhs) -15 Italy 5-year government bond, % (rhs) Dec 1 Jun 11 Dec 11 Jun 12 Dec 12, Bloomberg Fig. 5c: Wind Bond-Loan Yield Differential Bond-Loan Yield Differential, bps -2 Dec 1 Jun 11 Dec 11 Jun 12 Dec 12 Intermediate Capital Group plc Page 6

7 3. ISS Changing differentials between subordinated instruments with different seniority can also offer relative value opportunities. Again, we view the changing yield relationship between loans and bonds as often reflective of market conditions, as opposed to relative recovery expectations on default. This volatility offers opportunities to capture additional yield or capital gain, sometimes by taking better lending risks. ISS is one of the world s largest facility service companies providing cleaning, catering, security and support services to private and public institutions. ISS was taken private in 25 and since then has been an issuer in the high yield bond and loan markets. The charts below (Figure 6 a-c) demonstrate how ISS s second lien loan-subordinated bond relationship has varied over time: Fig. 6a: ISS Loan and Bond Price ISS Second Lien Loan Price 65 ISS 8.875% due 216 Bond Price 6 Jun 9 Dec 9 Jun 1 Dec 1 Jun 11 Dec 11 Jun 12 Dec 12 Fig. 6c: ISS Bond-Loan Yield Differential Bond-Loan Yield Differential, bps - Jun 9 Dec 9 Jun 1 Dec 1 Jun 11 Dec 11 Jun 12 Dec 12 The charts show that there have been periods where the ISS second lien has offered more spread than the subordinated high yield bond, despite ranking ahead of it in default. This is a strong illustration of the type of distortion a combined loan and high yield mandate could exploit. Whilst structural aspects of each debt instrument need to be taken into account, the technical separation of bond and loan investors has certainly, in this case, allowed this mispricing to exist. Fig. 6b: ISS Loan and Bond Yield 25 2 ISS Second Lien Loan Yield, % ISS 8.875% due 216 Bond Yield, % Jun 9 Dec 9 Jun 1 Dec 1 Jun 11 Dec 11 Jun 12 Dec 12 Intermediate Capital Group plc Page 7

8 Combined Senior Secured Loan & High Yield Bond Portfolios Structural differences between loans and bonds Structural differences between loans and bonds can be a significant driver of the additional value derived from a combined allocation to loans and bonds. We highlight a couple of examples below: Call protection Call protection gives an investor protection from the refinancing or repayment of a debt instrument. Fixed-rate high yield bonds typically offer call protection for a portion of a bond s life, whilst senior secured loans are typically callable at par at all times. Call protection can be a valuable feature in high yield bonds, guaranteeing the bondholder a fixed return during the noncall period, regardless of whether a borrower could refinance the bond by borrowing at a lower rate (for example, if they reduce debt or are acquired by an investment grade company, making them a better credit risk). In these situations, callable debt instruments are likely to be repaid or refinanced. If a lender wants to continue lending to the company, they may have to do so at a lower interest rate. Call protection can create a marked difference in the price upside available from buying a bond versus buying a loan. The chart below (Figure 7) shows how the price of a Libor+5 5 year callable loan and a 7% coupon (on a spread basis equating to Libor+5) non-callable 5 year bond vary by yield spread. The assumption we make is that, at prices above par, the borrower repays the loan within 12 months rather than repaying at maturity: Fig. 7: Effect of non-call on price performance Spread widening from issue level 85 5% 4% 3% 2% 1% Source: ICG L+5 callable loan 7% 5Y non-call bond Upside from call protection % Theoretical call 2.1% discount rate Loans price to 12 month refinancing Spread tightening from issue level The chart shows how the loan price is capped near par as the yield falls, reflecting the callability of the loan. However, the bond price can trade significantly above par as the bond s yield falls due to the inability of the borrower to call (repay or refinance) the loan before its maturity. There are various other aspects around bond documentation which play into this but are beyond the scope of this paper. -1% -2% -3% -4% -5% As an illustration, the chart below (Figure 8) shows the price development of two bonds issued by Rhodia since May 21: 1. A floating rate note (FRN) with a Libor + 275bps margin, callable at par. Although this is a bond it has the typical structure of a loan and is callable at any time 2. A 7% fixed-rate bond with identical seniority, with call protection for 4 years. Fig. 8: Relative Performance of Rhodia Debt Securities RHA 7% fixed 218 RHA L (callable) 9 May 1 Aug 1 Nov 1 Feb 11 May 11 Aug 11 Source: ICG Solvay acquisition Floating rate note called at par Upside constrained by callable feature Rhodia s operating performance and credit profile improved with the global economic recovery in 21, driving the price of Rhodia s fixed rate bonds higher. However, its floating rate notes were constrained around par. In April 211, single A- rated Solvay agreed to acquire Rhodia. The price of the Rhodia fixed-rate bonds climbed to 112% as investors priced in support from its highly rated parent. However, the FRN remained close to par as investors anticipated an imminent call at par. Given loans are generally repayable at par at any time, borrowers may seek to reduce their borrowing costs by asking existing lenders to reduce the interest rate charged on the loan. This may reflect strong operating performance (and therefore lower credit risk) or strong demand for the borrower s debt. In these situations, unresponsive lenders may be repaid at par and replaced with more supportive ones. Convatec is a well-known issuer in both the European loan and high yield bond markets. In the case of their senior loans, strong operating performance and market conditions allowed the company to obtain a reduction of their loan margins in October 212. The charts below show the price and yield development of the company s senior bonds and loans in 212. The yield on the company s loans falls by 5 basis points in October 212, reflecting the repricing. Intermediate Capital Group plc Page 8

9 Fig. 9a: Convatec Loan and Bond Prices Convatec Loan Price Convatec 7.375% due 217 Bond Price 9 Dec 11 Jun 12 Dec 12 Fig. 9b: Convatec Loan and Bond Yields Covenants Covenant packages vary widely across loans and bonds. Senior secured loan documents typically include a suite of financial covenants specifying performance hurdles over the life of the loan and a number of other covenants limiting what a company can do without having to seek lenders permission. Bonds typically contain fewer covenants, giving the company more freedom and bondholders less control. Covenants are designed to give lenders some control over a borrower s activities and the ability to engage with the borrower should it underperform. Whilst an underperforming borrower is not usually a good thing, covenants often give lenders the tools to renegotiate the terms of the loan. This might include raising the interest rate charged to reflect the increased risk in the deal. Covenants also often give lenders the ability to engage management and owners over company strategy and capital structure, helping to ensure that the lenders interests are looked after first and foremost Convatec Loan Yield, % Convatec 7.375% due 217 Bond Yield, % Loan repricing In contrast, bond covenants are typically less restrictive. Borrowers may have the ability to materially worsen a bondholder s position without violating the terms of the bond, for example, by taking on more debt to fund an acquisition. In addition, bondholders tend to be more passive investors as a group, with holdings generally more widely dispersed across institutions and the group, as a whole, being more anonymous and harder to identify. 4 3 Dec 11 Jun 12 Dec 12 The value of covenant protection is dependent on many factors, including jurisdiction and legal framework, the company s financial position, point in the credit cycle, management and owners. Companies that perform to plan and repay loans before they fall due may never breach a covenant in their loan agreement arguably covenants have less incremental value in these situations. However, in other situations, lenders can derive significant additional value from covenants beyond their bondholder counterparts. Investors with rigid mandates to invest in either bonds or loans cannot choose how they invest in a company, which in many ways undermines the credit analysis undertaken. Investing well in the sub-investment grade credit space requires an investor to evaluate relative spreads, structural, and legal considerations for each debt instrument, bond or loan, and then be able to invest freely across the capital structure. Intermediate Capital Group plc Page 9

10 Combined Senior Secured Loan & High Yield Bond Portfolios Market Size & Issuer Overlap We believe the European senior secured loan market is around 25-3bn by amount outstanding. The market is tracked by a number of indices trying to represent it: The CS Western European Leveraged Loan Index (WELLI) is a broad European loan market benchmark, comprising 274 issuers with 177bn of loans outstanding. Within this index, the top 2 issuers represent 32% of the index. The index contains a long tail of smaller issuers: of the 274 index constituents, 74 issuers had less than 2m of loans outstanding (an amount we would consider the absolute minimum for even limited liquidity in the secondary market for loans). The S&P ELLI index is a widely-followed and relatively broad index representing 13bn of loans outstanding. The S&P LCD flow names index is a narrow subset of this index (11 issuers), designed to reflect the prices of the most liquid loans in the market. Meaningful overlap exists between issuers in the loan market and the bond market, particularly at the large issuer level. For example: Of the 2 biggest constituent names in the CS Western European Leveraged Loan Index, 9 are existing high yield issuers. At least three of the other issuers are reported to be seeking a debut high yield bond issuance 7 of the 11 S&P flow name index constituents are existing high yield bond issuers Of all new high yield deals issued over the last 12 months, roughly 3% were also loan issuers. An investor should consider carefully whether to mandate separate managers to invest in high yield bonds and loans and take into account: A combined allocation to loan and high yield bond offers the widest possible universe to select the very best investment ideas. The ability to select instruments according to their attractiveness adds value. Owning both loans and bonds in a single company across two allocations when, for example, the bonds offer the best value, is not optimal The loan market tends to trade with a minimum size requirement, which can hinder efforts to construct adequately diversified portfolios. Combined mandates can overcome this issue and assist diversification. A loan portfolio, particularly one based on the largest, most-liquid loan names (which most new portfolios by definition will be), will likely have significant overlap with that investor s bond portfolio. This unintended overlap increases the risk of large principal losses in high default rate environments, due to lower diversification across the two portfolios. To illustrate the risks arising from buying overlapping portfolios, we have run extensive default simulations of a theoretical combined portfolio versus two portfolios managed separately with a 3% name overlap. The results show that the probability of large losses arising from high default rates is higher for separately managed portfolios, not by very much in absolute terms (as tail risks by definition are low), but in relative terms meaningfully. For example, looking at a year where market defaults peak at 1% (like 22 or 29 for example) the risk of experiencing portfolio losses of 2% or more for a randomly selected portfolio is 1.4% in the case of the combined portfolio, but 3.% for the overlapping portfolios. Similarly, if we looked through a full credit cycle assuming a 5% annual default rate over 5 years, the risk of cumulative losses in excess of 45% over the entire cycle would be.9% in the combined portfolio, but 2.3% in the separated portfolios. Intermediate Capital Group plc Page 1

11 Combined Senior Secured Loan & High Yield Bond Portfolios Increasing integration between bond and loan markets We believe that the senior secured loan and high yield bond markets will continue to integrate as borrowers refinance loans in the bond market. We see 4 main drivers for this: The senior secured loan maturity wall : The maturity profile of the European senior secured loan market is heavily weighted towards , reflecting the scheduled maturities of loans issued at the height of the leveraged buyout boom in As these maturities draw closer, management teams and owners are exploring refinancing options, including raising new loans, extending existing loans, exiting their investments via sale or IPO, and refinancing their loans in the high yield bond market CLO reinvestment periods: The European CLO buyer base largely consists of investment vehicles that pre-date the credit crisis. Very few new CLO vehicles have been formed since. The existing universe of CLOs are prohibited from investing in new loans beyond their stated reinvestment periods which largely expired in 212 or will expire in 213. As such, we expect that financing capacity for new senior secured loans from CLO lenders will be significantly lower going forward. Withdrawal from leveraged lending by banks: It is expected that banks will continue to retrench over the next few years, exiting or substantially reducing their leveraged lending businesses in the process. Reasons include prospective changes to reserve requirements for senior secured loans, tighter funding conditions across the banking sector, and political pressure to provide more traditional credit in home markets. As appetite for senior secured loans from the bank sector declines, borrowers will need to find alternative sources of debt funding Growth of the European high yield market: The European high yield market in recent years. The low interest rate environment makes it hard for income based investors to find suitable investment opportunities, making high yield bonds one of the few obvious choices. Favourable financing conditions have driven issuance, particularly from senior secured loan issuers (also see our note: European High Yield Bonds: New Issue Review ). Fig. 1: European CLO reinvestment capability Source: JPMorgan Structured Finance Research, INTEX Fig. 11: Leveraged Loan Maturity Schedule Source: S&P LCD Total Funded Amount by End of Reinvestment Period, EURbn YE 21 YE This trend has a number of implications: Longer-term, leveraged loans may be a smaller asset class than in the past as the amount of loans outstanding and also issuer numbers decline, particularly amongst the larger LBOs. In contrast, we expect the high yield market to continue to grow, partially reflecting senior secured loan issuers transitioning into this market The overlap between the loan issuer universe and the high yield issuer universe will increase. Loanonly asset managers cannot follow their investments into the high yield bond market, whilst high-yield only managers will not benefit from the experience of having known and invested in these companies as loan issuers. Managers with combined mandates will benefit from prior knowledge of these businesses which we see as a key advantage in reviewing any transaction Margins on new loans are likely to go up as the CLO buyer base shrinks and banks lending standards tighten. This is an opportunity for incoming investors into the loan market. Intermediate Capital Group plc Page 11

12 Combined Senior Secured Loan & High Yield Bond Portfolios Conclusion While investing in a High Yield Bond Fund or a Senior Secured Loan Fund are both attractive standalone investment opportunities for a long term investor, investing in a portfolio that can freely invest across both Senior Secured Loans and High Yield Bonds, with an experienced manger in both asset classes, can generate meaningful incremental benefits. We believe there are a number of reasons why this is the case: Pricing is inefficient. Positioning according to relative value between the two markets can improve returns Structural differences. Bonds and loans are structured differently and have different risk/return characteristics A combined mandate allows an asset manager to tailor their investment to credit view Market size. A combined mandate gives the asset manager a broader opportunity set to select from Separating allocations to High Yield and Leverage Loans can create name overlap risks Increasing integration between loan and bond markets. Issuers will continue to move between markets as funding conditions fluctuate Asset managers operating in both markets will have a better understanding of these names. Identifying where loans are over or under-valued versus high yield bonds and reallocating accordingly allows an asset manager to create a portfolio invested in the most attractive markets, companies, and debt instruments at any given point in time. Under fixed, separate mandates, each asset manager is forced to invest in his respective market even when the other asset class offers better value, with the bond/loan asset allocation decision one step removed. Reallocation decisions between loans and bonds under this framework are likely to be slower and more expensive than under a combined mandate. Fundamentally, we believe that delegating the allocation decision within these two closely-related markets to a single asset manager can enhance the potential risk and return outcomes available to investors. Intermediate Capital Group plc Page 12

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